The average investor needs an investment portfolio that includes bond funds (also called INCOME funds); and owning the best bond funds will be crucial in 2014. Investing money in or holding the wrong ones could be costly. At the same time, the best investment portfolio will likely be a portfolio that holds only a moderate amount of these best bond funds. Sound like a riddle? Read on.
Average investors need a balanced investment portfolio in order to earn higher returns at an acceptable level of risk. This is achieved by investing money in stocks, bonds, safe investments and alternative investments (like gold and real estate). Mutual funds are simply the average person’s best investment vehicle for investing money in these different areas… because they offer investors both professional management and instant diversification. Now, why is it so important to own the best bond funds in 2014?
If you had simply had half of your money in a bond fund and half in a diversified stock fund over the past 30 or so years, you would likely have outperformed most investors (both large and small). Why? Because long term debt securities called “bonds” have been steady performers and one of the best investments around, especially for investors in search of higher income with relative safety. Notice that I said “relative” safety, because in 2014 bonds and bond funds will NOT be safe investments… even the best bond funds.
Why were bond funds (also called INCOME funds) a “best investment” to hold for 30 years? Answer: interest rates were falling (think from double digits to all-time lows). When rates fall, bond prices (values) go up… because bonds pay a FIXED interest rate that never changes for the life of the investment… which is FIXED as well. These debt securities are usually issued for $1000 and on a given (fixed) date in the future they mature; and the investor holding it gets $1000 back. These securities also trade in the open market – and fluctuate in price like stocks do.
The best bond funds in a period of falling interest rates are those that hold these debt securities with maturity dates that go well into the future (like 20 years). That means that the owner (the fund) is locked into a relatively high interest rate for as long as they own these bond investments. Plus, the price (value) of the investment goes up as rates continue to fall. Bond funds invest money (investor money) in bonds, so a fund’s price or value reacts in step to the change in market value of these fixed income securities in their investment portfolio. Investing money in income funds means that you (the investor) own shares – you own a small part of a large investment portfolio that consists of bonds.
Many investors consider these income funds to be the best investment around. They’ve been investing money in them for years and have made good, consistent returns (better than stocks) for most of 30 years! They do not understand that yesterday’s best investment could become tomorrow’s nightmare on Main Street. How so? When interest rates rise like many economists expect in 2014 and beyond, it will be a whole new ball game for investors. If rates rise significantly, the bond market could fall like a rock. It could be the flip side of the coin compared to 30 years of falling interest rates.
When interest rates go UP, bond and income fund prices (values) go DOWN. Long-term bond funds that hold debt securities maturing (on average) 15, 20 or more years into the future will be worst hit. Yesterday’s best investment could be the worst investment in 2014 and beyond. The best bond funds will be INTERMEDIATE-TERM FUNDS: those holding debt securities that mature on average in 5 to 10 years. They will be much less affected by rising interest rates. Investing money there makes good sense, because there will always be uncertainty, and long-term investors need balance in their investment portfolio.
You may want to limit your holdings in income funds in general to about 30% of your total investment assets. Many investors have loaded up on bond funds and are still investing money in them. Don’t expect even the best bond funds to be your best investment in 2014 and beyond. Interest rates can’t fall much further, but the upside potential in rates is scary.
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